Analyst Lawsuits: Blaming The Cheerleader

Wall Street analysts have been heaped with all kinds of abuse lately, and for the most part they deserve it. The Securities and Exchange Commission, among others, has found that conflicts of interest among analysts run deep and wide, and that many have been shills for their investment banking departments.

Now securities lawyers have arrived on the scene like jackals on a wildebeest. They are starting to file lawsuits and are issuing their typical self-congratulations for discovering "fraud" that is already well known.

Although their prey is wounded, most of the claims will probably fail--if put to the test. But the plaintiffs are hoping the test will never come. They'd much rather negotiate a hefty settlement with the brokerage firms, the analysts' deep-pocketed employers.
Merrill Lynch
has already put blood in the water, settling an arbitration claim concerning their star,
Henry
Blodget
Henry Blodget
, for $400,000.

While the various analyst lawsuits differ in detail, they are of a type. In one typical case, investors in
Amazon.com
are suing
Morgan Stanley
and its hotshot Internet analyst
Mary
Meeker
Mary Meeker
. The plaintiffs claim that Meeker's advice to buy the stock was "false and misleading," and that she offered that advice not because she believed the shares were undervalued, but because she wished they would rise. The reason for her wish was that she wanted to help Amazon and attract it as a banking client--a classic conflict of interest, plaintiffs say.

Plug in a different stock--
eBay
, for instance--or a different analyst with a different investment bank and you get the idea.

Suing an analyst is like suing the cheerleader when your football team loses. Never mind that the quarterback is rag-armed, the line can't block, the halfback is a fumbler and the receivers stink. These investors would have the courts believe that they would never have bet on the team but for the fact that the cheerleaders were sexy.

Meeker's and Blodget's cheers may have lacked bases in fact. But investors bid up Amazon, CMGI
, iVillage
and AskJeeves
for the same reason as the analysts recommended them: they believed with all their heart. And until the bubble burst, everyone was happy.

Everyone knew--and the analysts wrote--that these companies had, as a rule, no profits and scant revenue. Belief in these companies was based on articles of faith, not facts. But for plaintiffs to prevail on fraud claims, they must prove a false statement of fact. This will be hard to do.

Investors face other problems, too. First, nearly all investors have signed arbitration agreements with their brokerage firms, says
Lester
Brickman
Lester Brickman
, a professor at Benjamin N. Cardozo School of Law in New York. These arbitration agreements generally operate to prevent class actions. For securities plaintiff lawyers, class actions are where the money is. Plaintiffs will argue that they have a right to sue as a class and to have those actions heard in federal court. Whether they have that right, despite the arbitration provision, has not been definitively determined, Brickman says.

If the plaintiffs do get to court, they will have to do more than say the analysts hyped the stock, or even that they had a conflict of interest that caused them to hype the stock. "Securities laws permit some level of puffery so long as it's not about a specific fact," says
G. Jack
Chin
G. Jack Chin
, a law professor at the University of Cincinnati. "It's hard to call something fraud if everybody knows the truth," Chin says. "Everybody knew Amazon had no earnings. People like Meeker just said that it might [in the future]."

Because their legal claims may be weak, plaintiffs might be better off appearing before arbitrators. While judges are bound by law, arbitrators have a freer hand. They may rule against analysts and their firms if a transaction fails a "smell test" even if the plaintiffs cannot demonstrate a particular false or misleading statement of fact. "Brokerage houses use arbitration clauses because they believe it's in their self-interest," says Brickman. "What I'm saying is man-bites-dog: a little-discussed detriment to the broker from arbitration."

Demonstrating that analysts may have had their heads turned by investment bankers and that something was somehow wrong (if not false) in their reports seems to be the strategy of
Eduard
Korsinsky
Eduard Korsinsky
, a New York lawyer who has filed several cases against analysts and their firms. "It's not the statements per se. It's the buy recommendations when the companies were experiencing worsening conditions, when they were bleeding cash," Korsinsky says.

He admits the complaints he has filed don't point to particular statements. He also says that the claims he has filed in state court don't allege fraud at all, but a breach of fiduciary duty, which can be easier to prove.

Korsinsky and his ilk may succeed, if not in court, then at the settlement table, where most such claims wind up. For now, the brokerage firms insist they have done nothing wrong. But having touted so many dubious enterprises, some of which are trading for less than the price of a cup of coffee, plaintiffs may be able to shame them into settlements.

This is fine because they should feel shame. But the analysts' fair-weather fans had larceny in their hearts too.